Variable Interest Entities

9 Months Ended

Jun. 30, 2019

Variable Interest Entities

Variable Interest Entities

Note 4 – Variable Interest Entities

In accordance with ASC 810, Consolidation, we assess our partnerships and joint ventures at inception, and when there are changes in relevant factors, to determine if any meet the qualifications of a variable interest entity (VIE). We consider a partnership or joint venture a VIE if it has any of the following characteristics: (a) the total equity investment is not sufficient to permit the entity to finance its activities without additional subordinated financial support, (b) characteristics of a controlling financial interest are missing (either the ability to make decisions through voting or other rights, the obligation to absorb the expected losses of the entity or the right to receive the expected residual returns of the entity), or (c) the voting rights of the equity holders are not proportional to their obligations to absorb the expected losses of the entity and/or their rights to receive the expected residual returns of the entity, and substantially all of the entity's activities either involve or are conducted on behalf of an investor that has disproportionately few voting rights.

We perform a qualitative assessment of each VIE to determine if we are its primary beneficiary. We conclude that we are the primary beneficiary and consolidate the VIE if we have both (a) the power to direct the activities that most significantly impact the VIE’s economic performance and (b) the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE. We consider the VIE design, the contractual agreements that define the ownership structure, distribution of profits and losses, risks, responsibilities, indebtedness, voting rights and board representation of the respective parties in determining if we are the primary beneficiary. We also consider all parties that have direct or implicit variable interests when determining whether we are the primary beneficiary. As required by ASC 810, our primary beneficiary assessment is continuously performed.

In March 2018, Cubic and John Laing, an unrelated company that specializes in contracting under public-private partnerships (P3), jointly formed Boston AFC 2.0 HoldCo. LLC (HoldCo). Also in March 2018, HoldCo created a wholly owned entity, Boston AFC 2.0 OpCo. LLC (OpCo) which entered into a contract with the Massachusetts Bay Transit Authority (MBTA) for the financing, development, and operation of a next-generation fare payment system in Boston (the MBTA Contract). HoldCo is 90% owned by John Laing and 10% owned by Cubic. Collectively, HoldCo and OpCo are referred to as the P3 Venture. Based on our assessment under ASC 810, we have concluded that OpCo and HoldCo are VIE’s and that we are the primary beneficiary of OpCo. Consequently, we have consolidated the financial statements of OpCo within Cubic’s consolidated financial statements. We have concluded that we are not the primary beneficiary of HoldCo, and thus we have not consolidated the financial statements of HoldCo within Cubic’s consolidated financial statements.

The MBTA Contract consists of a design and build phase of approximately three years and an operate and maintain phase of approximately ten years. The design and build phase is planned to be completed in 2021 and the operate and maintain phase will span from 2021 through 2031. MBTA will make fixed payments of $558.5 million, adjusted for incremental transaction-based fees, inflation, and performance penalties, to OpCo in connection with the MBTA Contract over the ten- year operate and maintain phase. All of OpCo’s contractual responsibilities regarding the design and development and the operation and maintenance of the fare system have been subcontracted to Cubic by OpCo. Cubic will receive fixed payments of $427.6 million, adjusted for incremental transaction-based fees, inflation, and performance penalties, under its subcontract with OpCo.

Upon creation of the P3 Venture, John Laing made a loan to HoldCo of $24.3 million in the form of a bridge loan that is intended to be converted to equity in the future in accordance with its equity funding responsibilities. Concurrently, HoldCo made a corresponding equity contribution to OpCo in the same amount which is included within equity of Noncontrolling interest in VIE in Cubic’s consolidated financial statements. Also, upon creation of the P3 Venture, Cubic issued a letter of credit for $2.7 million to HoldCo in accordance with Cubic’s equity funding responsibilities. HoldCo is able to draw on the Cubic letter of credit in certain liquidity instances, but no amounts have been drawn on this letter of credit as of June 30, 2019.

Upon creation of the P3 Venture, OpCo entered into a credit agreement with a group of financial institutions (the OpCo Credit Agreement) which includes a long-term debt facility and a revolving credit facility. The long-term debt facility allows for draws up to a maximum amount of $212.4 million; draws may only be made during the design and build

phase of the MBTA Contract. The long-term debt facility, including interest and fees incurred during the design and build phase, is required to be repaid on a fixed monthly schedule over the operate and maintain phase of the MBTA Contract. The long-term debt facility bears interest at variable rates of LIBOR plus 1.3% and LIBOR plus 1.55% over the design and build and operate and maintain phases of the MBTA Contract, respectively. At June 30, 2019, the outstanding balance on the long-term debt facility was $46.0 million, which is presented net of unamortized deferred financing costs of $8.8 million. The revolving credit facility allows for draws up to a maximum amount of $13.9 million and is only available to be drawn on during the operate and maintain phase of the MBTA Contract. OpCo’s debt is nonrecourse with respect to Cubic and its subsidiaries. The fair value of the long-term debt facility approximates its carrying amount.

The OpCo Credit Agreement contains a number of covenants which require that OpCo and Cubic maintain progress on the delivery of the MBTA Contract within a specified timeline and budget and provide regular reporting on such progress. The OpCo Credit Agreement also contains a number of customary events of default including, but not limited to, the delivery of a customized fare collection system to MBTA by a pre-determined date. Failure to meet such delivery date will result in OpCo, and Cubic via its subcontract with OpCo, to incur penalties due to the lenders.

OpCo has entered into pay-fixed/receive-variable interest rate swaps with a group of financial institutions to mitigate variable interest rate risk associated with its long-term debt. The interest rate swaps contain forward starting notional principal amounts which align with OpCo’s expected draws on its long-term debt facility. At June 30, 2019, the outstanding notional principal amounts on open interest rate swaps were $117.3 million. The fair value of OpCo’s interest rate swaps at June 30, 2019 was $16.9 million and is recorded as a liability in other long-term liabilities in our Consolidated Balance Sheets. OpCo’s interest rate swaps were not designated as effective hedges at June 30, 2019 and as such unrealized gains/losses are included in other income (expense), net. Unrealized losses as a result of changes in the fair value of OpCo’s interest rate swaps were $7.0 million and $16.9 million for the three- and nine-month periods ended June 30, 2019, respectively. See Note 13 for a description of the measurement of fair value of derivative financial instruments, including OpCo’s interest rate swaps.

OpCo holds a restricted cash balance which is required by the MBTA Contract to allow for the delivery of future change orders and unplanned expansions as directed by MBTA.

The assets and liabilities of OpCo that are consolidated into our Condensed Consolidated Balance Sheets at June 30, 2019 and September 30, 2018 are as follows:

	June 30,		September 30,
	2019		2018
	(in thousands)
Cash	$	359	$	374
Restricted cash		9,967		10,000
Other current assets		53		—
Long-term capitalized contract costs		—		33,818
Long-term contracts financing receivable		90,233		—
Other noncurrent assets		1,266		810
Total assets	$	101,878	$	45,002
Trade accounts payable	$	88	$	165
Accrued compensation and other current liabilities		183		—
Due to Cubic		19,460		11,724
Other long-term liabilities		16,897		13
Long-term debt		45,991		9,056
Total liabilities	$	82,619	$	20,958
Total Cubic equity		(510)		(304)
Noncontrolling interests		19,769		24,348
Total liabilities and owners' equity	$	101,878	$	45,002

The assets of OpCo are restricted for its use only and are not available for the general operations of Cubic. OpCo’s debt is non-recourse to Cubic. Cubic’s maximum exposure to loss as a result of its equity interest in the P3 Venture is limited

to the $2.7 million outstanding letter of credit, which will be converted to a cash contribution upon completion of the design and build phase of the MBTA Contract.

Prior to the adoption of ASC 606, Cubic and OpCo were precluded from recognizing revenue on the MBTA Contract because MBTA was not required to make payments to OpCo until the operate and maintain phase of the contract began. During this time period Cubic and OpCo were capitalizing costs associated with designing and building the system for MBTA. Upon the adoption of ASC 606, Cubic and OpCo no longer defer the recognition of revenue and costs related to the MBTA contract and therefore costs are no longer capitalized.

The revenue, operating income, and other income (expense), net of OpCo that are included in our Condensed Consolidated Statements of Operations are as follows:

	Three Months Ended				Nine Months Ended
	June 30,				June 30,
	2019		2018		2019		2018
Revenue	$	3,233	$	—	$	7,519	$	—
Operating income		2,823		—		6,521		—
Other income (expense), net		(7,031)		(2,090)		(16,884)		(2,090)
Interest income		1,075		—		2,335		—
Interest expense		(829)		—		(1,939)		—